Pragna Talks – Financial Federalism

Pragna Talks – Whether Financial Federalism — A talk by Sri Ch.V. Sai Prasad, IA & AS

Pragna Bharati organized a talk on Financial Federalism by Sri Sai Prasad on the evening of 7th May 2023 at FTCCI auditorium, Red Hills, Hyderabad.

Sri Sirish Dhopeshwar, President Pragna Bharati introduced the organization, and welcomed the keynote speaker and audience. He said there are many institutions which maintain fiscal prudence. Finance Commission doesn’t allow states to borrow from external agencies on their own. It is well-known that the 2008 economic recession has created havoc in US. Similarly lack of strong fiscal prudence has led to collapse of Silicon Valley Bank, Credit Suisse etc in the West.
Shri Pankaj Tiwari in his opening remarks said our federal structure distributes powers between states’ and central govts. He said lot of importance is given to central budgets, whereas state govt budgets are rarely discussed. Today with GST, central govt collects most taxes and distributes between states. He also introduced the keynote speaker, Sri Sai Prasad, IA&AS, who’s presently working in AGs office, Hyderabad.

Shri Sai Prasad in his keynote address stated that, he’s an old associate of Pragna Bharati and is happy to be present in the meeting.
Transfer of resources through the 3-tier system of center, states, and local body institutions/panchayats, started in 1860, when british govt started distribution of resources; before that the strong local bodies were completely self-sufficient, and these were subsequently impoverished by the British. The British later gave it a legislative framework through Govt of India Act 1935, which later continued in the Constitution of India. Finance Commission which is appointed once in 5 years, decides on the proportion of allocation of funds between center and states. Union govt through its discretionary powers distributes funds to states and local bodies.

Earlier before 2015, Planning Commission also used to give recommendations on fiscal policy and distribution of funds. Finance Commission studies the international situation and recommends policy of not only transfer of funds, but also augmenting of funds, rationalizing expenditures etc. Finance Commission visits all states, holds wide consultations and gives suggestions. States have generally requested reduction in the discretionary powers of center. Prior to 2015, states needed to take approvals from Planning commission for their own budgets and spending. Till 2015, till the end of term of 13th Finance Commission, only 32% of funds devolution to states was the norm, it was raised to 42% subsequently from 2015 onwards. The 14th Finance Commission headed by Sri YV Reddy, started devolution of funds to Local Bodies to the extent of Rs 2 Lakh crores. Higher allocation of funds by center led to higher discretionary spending by state govts. Giving grants-in-aid for specific programs of states has been done away with, which gives greater scope to states. For the purpose of Horizontal-based distribution of funds which fixes the ratio of distribution to states, Sri NK Singh led Finance Commission initially went back to the 1971 census, as per the requests of the states, especially in south, which felt that north india will get more weightage due to larger population in their states. Later it took into account 2011 census and gave weightage to higher migration rates to south, better ecological cover etc

Govt of India removed the nuisance of Planning Commission and replaced it with NITI Ayog which conducts studies and consultations and gives recommendations to the govt. Central Govt also removed the demarcation between plan and non-plan expenditure. Initially only 2% of GDP was contributed by people, later govt expanded extensively, into almost all sectors and walks of life, and hence today almost 17% is being contributed by people.
Public-private partnerships focused on infrastructure, most infrastructure was being built by private players; govt started numerous programs in the name of people’s welfare. Even though govt was in the business of supplying even milk, food items etc, India was the most privatised economy then. Today increasingly govt has become more welfare- oriented, with populist measures and freebies.
Because of increasing freebies, state govts and center have been borrowing recklessly, in a non-transparent, non-accountable manner. Govts are entering into SBAs (special banking arrangements), in which govt was paying excessive interests to agencies, for subsidizing welfare schemes. Hence there’s a great need for fiscal consolidation. To get state govts to follow fiscal discipline, central govt had to offer some lollipops to states. Later again indiscriminate debt wavers, other welfare schemes were announced and implemented. By 2018, all state govts breached all FRBM norms.

Most state govts, overstate their budgets or they do what’s called ‘over- budgeting’ to convince the voters that they are indeed doing great work. State govts are creating corporations which can borrow on their behalf. Most state govts have become revenue-deficit, and are asking for grants. 17 states have been given more than Rs 2 Lakh crores. Some revenue-deficit states are non-viable, called ‘special category states’, which are given support by center. Populism has made majority of states revenue-deficit, including big states like TN, KN, Kerala, AP, TS etc. Populist schemes of debt waivers, like raithu bandhu, amma vodi, waiver of farm loans etc cannot be supported, hence GoI has set deadlines for giving continuous grants to states.

Govt of TS, in 2014-15, used to spend Rs 5K crores as interests, today more than 30% is being paid as interests by TS govt. As they cannot avoid govt staff salaries and pensions, they have stopped many utility schemes like school fees reimbursement, interest-free loans to the poor etc. Infrastructure spending has come to a nought. Though we highlight higher GST collections, if we actually calculate the expected amount of taxes, it’s far less still; GST is still voluntary, automated GST tax regime is still not being implemented. GST is zero on 180 food and essential items, and the input /inversion of tax system, is unable to take advantage of what was conceived in the GST planning. Sri Sai Prasad concluded his talk by saying that the topic is so vast and complex, and he touched only a few aspects. The session was followed by a lengthy and lively Q&A session.